You decide: Who controls the Federal Reserve

One of my favorite topics, both when I was
teaching at NCSU and now as I continue to speak to various groups, is the
Federal Reserve.  To me, the Federal
Reserve (the Fed) is interesting because it has the
power to significantly influence the economy, yet many people are unaware of
its powers and who controls that power. 

The question of who controls the Fed is an
important issue of discussion today. President Trump is not happy with the Fed’s recent actions on interest
rates, and consequently he has talked about replacing the current chairperson
of the Fed, Jerome Powell. Powell has responded by asserting the President cannot replace him before his
term has concluded if their disagreement is simply over policy.

Who is correct in this dispute and why
does it matter?  In today’s column I’ll
present the facts and let you decide.

But first, a review of the role and
importance of the Fed is useful background for understanding today’s
dispute.  The Fed can be viewed as the
nation’s central bank.  In this role, the
Fed has regulatory controls over banks, it controls the supply of our common
currency, the dollar, and it implements monetary policy.  Monetary policy means the Fed uses its
control of the money supply to influence interest rates, which in turn
influences how fast or slow the economy grows.

The last five years provide a textbook
example of the Fed using monetary policy to change the economy.  During the economic uncertainty of the Covid
years, including 2020 and 2021, the Fed pumped significantly more cash into the
economy and caused interest rates to fall. The Fed’s goal was to motivate more
borrowing and spending to help the economy recover from the Covid recession.

However, with the benefit of hindsight, in
2022 the Fed realized it had overdone the spending stimulation when inflation
began to surge.  Hence, with the Covid
crisis appearing to be under control, the Fed reversed course and pushed for
higher interest rates to slow the pace of price increases.  Interest rates rose to levels above the
pre-Covid years, consumer spending slowed, and the annual inflation rate
dropped from over 9% to near 2.5%.

Now there is a debate about how the Fed
should move next, and this debate is at the core of the dispute between Trump and Powell. Trump wants the Fed to use its powers to lower interest rates
more. Powell and other
members of the Fed’s governing board have expressed concern that the president’s tariff policies could result in higher domestic prices and hence a
higher inflation rate.  They worry
further lowering of interest rates would stimulate more consumer spending which
would push inflation even higher.  Hence,
it now looks unlikely the Fed will move to reduce interest rates at its next
policy meeting in early May.

Disagreements over Fed policy are not
unusual.  Today there are different
economists who think the Fed should lower interest rates, raise interest rates,
or leave rates stable.  Of course, the
differences in opinion between the president and the Fed chair are more
notable because each has some power to back-up their opinion.  The question today is how much power?

While Powell is the “face” of
the Fed, the chair shares power with the other six members of the Fed’s Board
of Governors.  At meetings to determine
monetary policy, the chair has one vote, just like the other Board
members.  The chairperson serves a four
year term, while the other Board members have staggered 14-year term.  All are appointed by the president – but not
necessarily the same president – and confirmed by the Senate. Powell was first appointed by Trump during the first Trump term, and then was reappointed by
President Biden. Powell’s current
term ends in May 2026.

The Federal Reserve’s charter states a Fed
Board member, including the chairperson, can be removed prior to their term’s
expiration for “cause.”  “Cause” has
traditionally been interpreted as removal for serious misconduct or abuse of
power, and not for policy disagreements. 
Indeed, a Supreme Court ruling affirmed this interpretation in
1935. 

The creators of the Federal Reserve in the
early 20th century wanted the agency to be independent.  This means restricting the President and the
Congress from interfering in the Fed’s actions. 
Many interpret this objective as an intent to keep politics out of the
Fed’s decision-making, thereby allowing the Fed to focus solely on economic goals
like keeping both unemployment and inflation at relatively low levels.

Of course, whenever vague wording like
“for cause” is used, the table is set for different interpretations and
potential court cases.  If Trump “fires” Powell, one potential outcome is the chair then
files a lawsuit that likely works its way up to the Supreme Court.  The stock market would likely respond by
falling, as uncertainty in economic policy would be a consequence until the
courts provide a final verdict.

Hence, while each of us can decide who
should control the Federal Reserve, the final answer would likely come from the
courts.

____________________

Dr. Mike Walden
is a Reynolds Distinguished Professor Emeritus at North Carolina State
University.